PENSION BUST: Stockton, CA Seeks to Rewrite Bankruptcy Law

It’s no secret that pension obligations are causing cities across the country to see red on their balance sheets. While responsible city governments and managers nationwide are looking at ways to trim the fat, Stockton, California is trying a different strategy. Stockton’s approach was inspired by none other than our venerable leader, President Obama. According to the Wall Street Journal:

Just as the Obama Administration bailed out the United Auto Workers in Chrysler’s bankruptcy while hanging bondholders out to dry, the city of Stockton is subordinating its bond debt to worker pensions. But what’s really scary is that the Stockton case could be replayed in dozens of California cities.

Who cares what happens in a city in California? This end-run on bondholder rights could set a dangerous precedent. If bondholders are not repaid first, as most terms of muni bonds require, this obviously increases the risk of investment in municipal bonds. Translation: it will be costlier for cities to raise money for important capital expenditures, like education, transportation, and public safety projects.

According to Bloomberg‘s review of court documents, Stockton has argued the bonds are an unsecured liability that may not be entitled to full repayment in the bankruptcy process. Not surprisingly, the bond issuer has asked the bankruptcy judge in the case to toss the case out of court.

In Stockton, pension bondholders and the insurers backing their claims may not be repaid in full. In court documents, the city has argued the bonds are an unsecured liability that may not be entitled to full repayment. Bond insurer Assured Guaranty Corp. has asked the judge overseeing Stockton’s bankruptcy to throw the case out of court.

California cities aren’t the only localities that are struggling under the weight of pensions. Colorado’s Public Employees’ Retirement Association has also come under fire for its lack of unfunded liabilities. Could Colorado default on municipal bondholders’ right of repayment?

Either way, if Stockton is successful in its argument that bonds are an unsecured liability, Colorado could face difficulty in raising money for necessary municipal projects.